Testing for horizontal and vertical foreign investment spillovers in China, 1998–2007

► Using Chinese firm-level data, we show that foreign investment originating outside of Hong Kong, Macau, and Taiwan has positive effects on individual firm level productivity. ► At sector-level, we find zero or weak positive horizontal externalities (within the same sector) from foreign direct investment (FDI). ► However, our results show that FDI has generated positive productivity spillovers to domestic firms via backward linkages as well as forward linkages. As with many developing countries, the Chinese government hopes that knowledge brought by multinationals will spill over to domestic industries and increase their productivity. In this paper, we show that foreign investment originating outside of Hong Kong, Macau, and Taiwan has positive effects on individual firm level productivity, while foreign investment from HKMT firms does not. We also test for both horizontal (within the same industry) and vertical (upstream or downstream) linkages from foreign investment. Using a manufacturing firm-level panel for 1998 through 2007, we find zero or weak positive horizontal externalities. However, our results show that foreign direct investment (FDI) has generated positive productivity spillovers to domestic firms via backward linkages (the contacts between foreign affiliates and their local suppliers in downstream sectors) as well as forward linkages (between foreign suppliers and their local buyers in the upstream sectors).